It is the second great airwave auction: one that will usher in a new generation of souped-up mobile phones, super-speed broadband and high-definition TV channels, raising billions of pounds for the Treasury in the process. Or so it is hoped.

Next year, media regulator Ofcom, better known for handling complaints about crooked TV quiz shows or lambasting the BBC for allowing on-air profanities, will begin selling off a huge tranche of frequencies to be vacated by broadcasters when the analogue TV signal is switched off in 2012. It is a resource no one can see, but disposing of this invisible network could prove to be one of Ofcom's most enduring legacies.

By the time it is complete, Britain may resemble South Korea, whose eagerness to embrace new technology has helped to turn its capital, Seoul, into a test bed for new services at the forefront of digital innovation. Broadband take-up in the city is 93 per cent, the highest in the world, and virtually every office and home benefits from inexpensive wi-fi internet access; citizens can surf the web on a virtual network provided by companies that don't have to dig up roads to create it. This utopian vision of a connected world may not be realised in the UK overnight, but next year's auction of the UHF spectrum could bring it closer.

Ofcom is confident it will entice some of the world's biggest technology companies, including Microsoft and Google, to launch ambitious new products in Britain. Google has big plans for its mobile phone, and industry sources confirm it is considering a bid for the new spectrum, which would overnight turn it into a major competitor to Vodafone and O2

When the last set of airwaves went on the block in 2000, mobile phone companies were keen to launch '3G' services, which allow customers to use handsets to watch video and surf the internet. They bid record amounts to bag the licences, paying £23bn to the government and boosting its coffers more than even the most optimistic forecast. The latest spectrum on the market is even more powerful and potentially more valuable. 'If this was real estate, it would be Chelsea and Kensington,' says a senior Ofcom source.

It sits in the middle of the UHF frequency, a 'sweet spot' that makes its incredibly attractive to telecoms companies, who could use it to launch wireless broadband up to 10 times faster than at present. Broadcasters could use it to roll out a new generation of free-to-air, high-definition TV channels.

Ofcom has started to market the spectrum discreetly in the past few weeks, presenting it to companies who want to protect and enhance their UK services, as well as potential new entrants who could use it to establish a presence in one of the world's most advanced media markets relatively cheaply.

Britain will be one of the first to turn off the old analogue signal, which was used by the big terrestrial broadcasters for 50 years or more. The government's decision to switch to digital TV by 2012 has proved controversial, not least because of the confusion it could cause. Viewers who don't already have cable or satellite services will have to buy new kit - a digital TV or set-top box - to continue receiving their favourite programmes.

But the amount raised by selling off the spare analogue signal, the so-called 'digital dividend', could provide the Treasury with some much-needed cash, and the range of services that could use it will place the UK at the vanguard of technological innovation.

Crucially, the chunk of analogue space being sold is high frequency, meaning a high-quality signal that can reach a wider area easily. The spectrum currently used by mobile phone companies is weaker, meaning more base stations need to be built to ensure customers receive a good service. They are expensive to construct and difficult to roll out, often meeting resistance from planners. The new spectrum in effect provides a ready-made network, requiring few modifications or additional capital expenditure, and that could allow a new entrant to establish a national presence within a few years.

That has prompted interest from some of the world's most valuable companies, including Google, which is placing huge resources behind its new Google phone. Senior industry sources confirm it is considering a bid. Google's new handset, which will compete with Apple's iPhone, will give users access to services such as Google Earth, which could be adapted to provide customers with information on everything from road maps to where to find local shops and restaurants. It would be cheaper to sign a deal with an existing mobile provider, as Apple has done, piggybacking on its network and sharing profits. But buying a licence outright would allow Google to keep all the revenue, give it greater control over marketing, and could even allow it to drop monthly rental charges for the device.

That may not be as risky, or as expensive, as it sounds. Google's search engine is funded almost entirely by advertising, and applying the same business model to its phone could generate enough revenue to fund this plan. A Google handset with no contract would be hugely popular, placing it in the hands of millions of consumers and creating a valuable new captive audience for advertisers.

It would also represent a huge challenge for existing operators and encourage them to outbid Google next year. Ofcom is keen to attract new entrants to maximise profits from the spectrum auction. In 2000, the arrival of mobile phone company 3, owned by Asian conglomerate Hutchison Whampoa, boosted prices as incumbent operators, fearful of losing market share, raised the stakes.

But some warn that the 'digital dividend' is unlikely to be anywhere near the amount raised eight years ago, when telecoms companies, buoyed by the dotcom bubble, bid huge amounts for licences. At that time, it was far easier to borrow money and the economic climate was benign, but many of the operators who paid billions to secure space on the 3G spectrum are still paying the price now, scaling back expansion plans in other markets because of the huge debts they ran up in the UK.

After being burnt once, they are unlikely to break the bank a second time, and a looming downturn will make them even more cautious. Telecoms companies, technology groups and broadcasters are likely to see revenues fall as recession bites, and reluctant capital markets means they may not be able to raise the billions of pounds needed for a bid. However, a similar auction for new spectrum in America earlier this year raised $20bn for the US government, more than anticipated and exceeding what the US Treasury received for its own '3G' auction at the turn of the last decade.

Like property, the value of the latest spectrum will be determined by the market and it may not be the best time to sell. But if Ofcom can persuade internet giants with deep pockets to join the race, the government could receive a larger 'digital dividend' than expected.